Commonly used by real estate investors, an equity dividend rate is a useful metric to determine an investment's annual return relative to the initial amount of money invested. Also known as the cash-on-cash return, this metric focuses entirely on the actual amount of cash invested in a property, not the purchase price. In a nutshell, the equity dividend rate is an excellent way to determine the annual profitability of a real estate investment.
Calculating the equity dividend rate
First, add up the total income the property produced over the course of a year. Be sure to include all sources of income, not just the rent collected. For example, many apartment properties get extra revenue from coin-operated laundry machines, and some properties require tenants to pay for parking. This is the gross income of the property.
Next, add up all of the property's operating expenses, which may include
- Landlord-paid utilities
- Property taxes
Then, subtract the operating expenses from the gross income to calculate your net operating income, or NOI.
Next, add up all of your debt service (mortgage) payments, and subtract this amount from the NOI to arrive at the property's pre-tax cash flow.
Finally, divide the pre-tax cash flow by the cash you initially invested, such as the down payment and any closing costs you paid to acquire the property, as well as any renovations or other initial investments. Multiply this amount by 100 to convert it to a percentage -- this is your equity dividend rate.
Let's say that you purchase a small apartment building for $1,000,000, and that you spend $250,000 to acquire the property.
The apartments generate $100,000 in annual rent, and the laundry machines in the building produce another $5,000 for a gross income of $105,000. And, we'll say that the property's operating expenses for the year come to $30,000. So, the net operating income for the year is $75,000.
Finally, let's say that your mortgage payments come to $50,000, leaving you with a pre-tax cash flow of $25,000 ($75,000-$50,000). Dividing this amount by the initial $250,000 investment, and multiplying by 100 produces an equity dividend rate of 10%.
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